Defining Benefits Down

I have long thought that Defined Benefit plans are the best retirement plans for workers. They are also the worst for employers. Why?

Employees are incapable of making intelligent investment decisions in aggregate, much as they like the feeling of “control.” Far better to have professionals choose investments where they don’t give in (as much) to fear and greed, and lose a lot of money in the process.

Defined benefits give retirees a fixed budget, which is good; they are not capable of managing a lump sum over a lifetime. Indeed that would tax most “professionals.” The pensions are also judgment-proof, aside from QDROs.

The cost of providing fixed benefits amid low interest rates is tough for most employers, who have seen their liabilities expand dramatically. It takes a lot more assets to provide a pension if you are investing in safe bond investments.

This is particularly true for public pensions, since they had the greatest tendency to defer making contributions to avoid raising taxes. Now they are in the soup. It will be interesting to see what the municipalities do with the pensions. There may be compromises driven over retirement benefits for future employees, current employees, and even current retirees. Then again, maybe taxes will be raised to cover the expense.

That will vary by state; some will accept more taxes, and some won’t… beyond that, some will move out of high taxation states, creating a “death spiral” for taxes, or a default/compromise on pension payments.

All that said, I can simply say that in a period of low interest rates and low returns from risk assets, it is unlikely that pension payments will be maintained in many states, unless taxes are raised, and many will oppose that, because their own retirements so not look so promising.

Author: David MerkelDavid J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately.
From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies.
Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.
From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that.
Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.
My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog.
I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.